Question: Piglet Pies has issued a zero-coupon

> Jim Khana, the credit manager of Velcro Saddles, is reappraising the company’s credit policy. Velcro sells on terms of net 30. Cost of goods sold is 85% of sales, and fixed costs are a further 5% of sales. Velcro classifies customers on

> Phoenix Lambert currently sells its goods cash-on-delivery. However, the financial manager believes that by offering credit terms of 2/10 net 30 the company can increase sales by 4%, without significant additional costs. If the interest rate is 6% and th

> Listed below are some common terms of sale. Can you explain what each means? a. 2/30, net 60 b. 2/5, EOM, net 30 c. COD

> Consider three securities: a. A floating-rate bond b. A preferred share paying a fixed dividend c. A floating-rate preferred If you were responsible for short-term investment of your firm’s excess cash, which security would you probably prefer to hol

> Look back at Section 30-2. Cast Iron’s costs have increased from $1,000 to $1,050. Assuming there is no possibility of repeat orders, answer the following: a. When should Cast Iron grant or refuse credit? b. If it costs $12 to determine whether a custome

> Company X sells on a 1/30, net 60 basis. Customer Y buys goods invoiced at $1,000. a. How much can Y deduct from the bill if Y pays on day 30? b. What is the effective annual rate of interest if Y pays on the due date rather than on day 30? c. How wou

> Large businesses spend millions of dollars annually on insurance. Why? Should they insure against all risks or does insurance make more sense for some risks than others?

> What are the trade-offs involved in the decision of how much inventory the firm should carry?

> Galenic, Inc., is a wholesaler for a range of pharmaceutical products. Before deducting any losses from bad debts, Galenic operates on a profit margin of 5%. For a long time the firm has employed a numerical credit scoring system based on a small number

> Reliant Umbrellas has been approached by Plumpton Variety Stores of Nevada. Plumpton has expressed interest in an initial purchase of 5,000 umbrellas at $10 each on Reliant’s standard terms of 2/30, net 60. Plumpton estimates that if the umbrellas prove

> Suppose you are a wealthy individual paying 35% tax on income. What is the expected after-tax yield on each of the following investments? a. A municipal note yielding 7.0% pretax. b. A Treasury bill yielding 10% pretax. c. A floating-rate preferred st

> The IRS prohibits companies from borrowing money to buy tax-exempts and deducting the interest payments on the borrowing from taxable income. Should the IRS prohibit such activity? If it didn’t, would you advise the company to borrow to buy tax-exempts?

> In 2006 agency bonds sold at a yield of 5.32%, while high-grade tax-exempts of comparable maturity offered 3.7% annually. If an investor receives the same after-tax return from corporates and tax-exempts, what is that investor’s marginal rate of tax? Wha

> In Section 30-4 we described a three-month bill that was issued on an annually compounded yield of 5.16%. Suppose that one month has passed and the investment still offers the same annually compounded return. What is the percentage discount? What was you

> A three-month Treasury bill and a six-month bill both sell at a discount of 10%. Which offers the higher annual yield?

> Lockboxes The financial manager of JAC Cosmetics is considering opening a lockbox in Pittsburgh. Checks cleared through the lockbox will amount to $10,000 per day. The lockbox will make cash available to the company three days earlier than is currently t

> A parent company settles the collection account balances of its subsidiaries once a week. (That is, each week it transfers any balances in the accounts to a central account.) The cost of a wire transfer is $10. A check costs $.80. Cash transferred by wir

> a. Marshall Arts has just invested $1 million in long-term Treasury bonds. Marshall is concerned about increasing volatility in interest rates. He decides to hedge using bond futures contracts. Should he buy or sell such contracts? b. The treasurer of Ze

> Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lockbox system. She forecasts that 300 payments a day will be made to lockboxes, with an average payment size of $1,500. The bank’s charge for operating the lockboxe

> Knob, Inc., is a nationwide distributor of furniture hardware. The company now uses a central billing system for credit sales of $180 million annually. First National, Knob’s principal bank, offers to establish a new concentration banking system for a fl

> Look again at the previous problem. Suppose another month has passed, so the bill has only one month left to run. It is now selling at a discount of 3%. What is the yield? What was your realized return over the two months? Previous problem: In Section 30

> Look at the previous problem. Assume that the change in credit terms results in a 2% increase in sales. Recalculate the effect of the changed credit terms. Previous problem: Until recently, Augean Cleaning Products sold its products on terms of net 60, w

> As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently running at 6%. He believes that imposing a more stringent credit policy might reduce sales by 5% and reduce the bad debt ratio to

> Some of the items in the previous problem involve a cash discount. For each of these, calculate the rate of interest paid by customers who pay on the due date instead of taking the cash discount.

> For each item below, choose the investment that best fits the accompanying description: a. Maturity often overnight (repurchase agreements/bankers’ acceptances) b. Maturity never more than 270 days (tax-exempts/commercial paper) c. Issued by the U.S.

> In October 2008, six-month (182-day) Treasury bills were issued at a discount of 1.4%. What was the annual yield?

> Complete the passage that follows by choosing the appropriate terms from the following list: lockbox banking, Fedwire, CHIPS, concentration banking. Firms can increase their cash resources by speeding up collections. One way to do this is to arrange for

> How should your willingness to grant credit be affected by differences in (a) the profit margin, (b) the interest rate, (c) the probability of repeat orders? In each case illustrate your answer with a simple example.

> You own a $1 million portfolio of aerospace stocks with a beta of 1.2. You are very enthusiastic about aerospace but uncertain about the prospects for the overall stock market. Explain how you could hedge out your market exposure by selling the market sh

> True or false? a. Exporters who require greater certainty of payment arrange for the customers to sign a bill of lading in exchange for a sight draft. b. It makes sense to monitor the credit manager’s performance by looking at the proportion of bad deb

> Look back at the discussion in Section 30-2 of credit decisions with repeat orders. If p1 = .8, what is the minimum level of p2 at which Cast Iron is justified in extending credit?

> The Branding Iron Company sells its irons for $50 apiece wholesale. Production cost is $40 per iron. There is a 25% chance that wholesaler Q will go bankrupt within the next year. Q orders 1,000 irons and asks for six months’ credit. Should you accept th

> The lag between the purchase date and the date on which payment is due is known as the terms lag. The lag between the due date and the date on which the buyer actually pays is the due lag, and the lag between the purchase and actual payment dates is the

> Table 29.19 shows the 2016 financial statements for the Executive Cheese Company. Annual depreciation is 10% of fixed assets at the beginning of the year, plus 10% of new investment. The company plans to invest a further $200,000 per year in

> Bio-Plasma Corp. is growing at 30% per year. It is all-equity-financed and has total assets of $1 million. Its return on equity is 20%. Its plowback ratio is 40%. a. What is the internal growth rate? b. What is the firm’s need for external financing th

> a. What is the internal growth rate of Eagle Sport (see Problem 24) if the dividend payout ratio is fixed at 60% and the equity-to-asset ratio is fixed at two-thirds? b. What is the sustainable growth rate? Problem 24: The financial statements of Eagle S

> The financial statements of Eagle Sport Supply are shown in Table 29.18. For simplicity, “Costs” include interest. Assume that Eagle’s assets are proportional to its sales. a. Find Eagle&

> a. Use the Dynamic Mattress model (Tables 29.9 to 29.11) and the spreadsheets to produce pro forma income statements, balance sheets, and statements of cash flows for 2016 and 2017. Assume business as usual except that now sales and costs are planned to

> Construct a new model for Dynamic Mattress based on your answer to Problem 21. Does your model generate a feasible financial plan for 2016? Problem 21: The balancing item in the Dynamic long-term planning model is borrowing. What is meant by balancing i

> What is basis risk? In which of the following cases would you expect basis risk to be serious? a. A broker owning a large block of Disney common stock hedges by selling index futures. b. An lowa corn farmer hedges the selling price of her crop by selling

> Define the following terms: a. Spot price b. Forward vs. futures contract c. Long vs. short position d. Basis risk e. Mark to market f. Net convenience yield

> How would the lessee in Figure 25.1 evaluate the NPV of the lease?
Sketch the correct valuation procedure. Then suppose that the equity lessor wants to evaluate the lease. Again sketch the correct procedure. (Hint: APV. How would you calculate the c

> How does the position of an equipment lessor differ from the position of a secured lender when a firm falls into bankruptcy? Assume that the secured loan would have the leased equipment as collateral. Which is better protected, the lease or the loan? Doe

> The Safety Razor Company has a large tax-loss carry forward and does not expect to pay taxes for another 10 years. The company is therefore proposing to lease $100,000 of new machinery. The lease terms consist of eight equal lease payments prepaid annual

> Nodhead College needs a new computer. It can either buy it for $250,000 or lease it from Compulease. The lease terms require Nodhead to make six annual payments (prepaid) of $62,000. Nodhead pays no tax. Compulease pays tax at 35%. Compulease can depreci

> A lease with a varying rental schedule is known as a structured lease. Try structuring the Greymare Bus Lines lease to increase value to the lessee while preserving the value to the lessor. Assume that Greymare does not pay tax. (Note: In practice the t

> In Section 25-5 we stated that if the interest rate were zero, there would be no advantage in postponing tax and therefore no advantage in leasing. Value the Greymare Bus Lines lease with an interest rate of zero. Assume that Greymare does not pay tax. C

> In Section 25-5 we listed four circumstances in which there are potential gains from leasing. Check them out by conducting a sensitivity analysis on the Greymare Bus Lines lease, assuming that Greymare does not pay tax. Try, in turn, a. a lessor tax rat

> n Section 25-4 we showed that the lease offered to Greymare Bus Lines had a positive NPV of $820 if Greymare paid no tax and a +$700 NPV to a lessor paying 35% tax. What is the minimum lease payment the lessor could accept under these assumptions? What i

> The Surplus Value Company had $10 million (face value) of convertible bonds outstanding in 2015. Each bond has the following features. Face value....................................$1,000 Conversion price..........................$25 Current cal

> Johnny Jones’s high school derivatives homework asks for a binomial valuation of a 12-month call option on the common stock of the Overland Railroad. The stock is now selling for $45 per share and has an annual standard deviation of 24%

> Explain carefully why bond indentures may place limitations on the following actions: a. Sale of the company’s assets. b. Payment of dividends to shareholders. c. Issue of additional senior debt.

> a. If interest rates rise, will callable or noncallable bonds fall more in price? b. Sometimes you encounter bonds that can be repaid after a fixed interval at the option of either the issuer or the bondholder. If the exercise price of each option is the

> Suppose that a company simultaneously issues a zero-coupon bond and a coupon bond with identical maturities. Both are callable at any time at their face values. Other things equal, which is likely to offer the higher yield? Why?

> After a sharp change in interest rates, newly issued bonds generally sell at yields different from those of outstanding bonds of the same quality. One suggested explanation is that there is a difference in the value of the call provisions. Explain how th

> a. Residential mortgages may stipulate either a fixed rate or a variable rate. As a borrower, what considerations might cause you to prefer one rather than the other? b. Why might holders of mortgage pass-through certificates wish the mortgages to have a

> Elixir Corporation has just filed for bankruptcy. Elixir is a holding company whose assets consist of real estate worth $80 million and 100% of the equity of its two operating subsidiaries. It is financed partly by equity and partly by an issue of $400 m

> Proctor Power has fixed assets worth $200 million and net working capital worth $100 million. It is financed partly by equity and partly by three issues of debt. These consist of $250 million of First Mortgage Bonds secured only on the company’s fixed as

> Bond prices can fall either because of a change in the general level of interest rates or because of an increased risk of default. To what extent do floating-rate bonds and puttable bonds protect the investor against each of these risks?

> Suppose that the J.C. Penney bond was issued at face value and that investors continue to demand a yield of 8.25%. Sketch what you think would happen to the bond price as the first interest payment date approaches and then passes. What about the price of

> Maple Aircraft has issued a 4¾% convertible subordinated debenture due 2020. The conversion price is $47.00 and the debenture is callable at 102.75% of face value. The market price of the convertible is 91% of face value, and the price of the common is $

> For which of the following options might it be rational to exercise before maturity? Explain briefly why or why not. a. American put on a non-dividend-paying stock. b. American call—the dividend payment is $5 per annum, the exercise price is $100, a

> True or false? Briefly explain in each case. a. It is better to hold unsecured bonds than secured bonds in the event of default. b. Many new and exotic debt securities are triggered by government policies or regulations. c. Call provisions give a valuabl

> a. As a senior bondholder, would you like the company to issue more junior debt to finance its investment program, would you prefer it not to do so, or would you not care? b. You hold debt secured on the company’s existing property. Would you like the co

> Occasionally it is said that issuing convertible bonds is better than issuing stock when the firm’s shares are undervalued. Suppose that the financial manager of the Butternut Furniture Company does have inside information indicating that the Butternut s

> This question illustrates that when there is scope for the firm to vary its risk, lenders may be more prepared to lend if they are offered a piece of the action through the issue of a convertible bond. Ms. Blavatsky is proposing to form a new start-up fi

> Dorlcote Milling has outstanding a $1 million 3% mortgage bond maturing in 10 years. The coupon on any new debt issued by the company is 10%. The finance director, Mr. Tulliver, cannot decide whether there is a tax benefit to repurchasing the existing bo

> Zenco, Inc. is financed by 3 million shares of common stock and by $5 million face value of 8% convertible debt maturing in 2026. Each bond has a face value of $1,000 and a conversion ratio of 200. What is the value of each convertible bond at maturity i

> In 1996, Marriott International made an issue of unusual bonds called liquid yield option notes, or LYONS. The bond matured in 2011, had a zero coupon, and was issued at $532.15. It could have been converted into 8.76 shares. Beginning in 1999 the bonds

> Iota Microsystems’ 10% convertible is about to mature. The conversion ratio is 27. a. What is the conversion price? b. The stock price is $47. What is the conversion value? c. Should you convert?

> Alpha Corp. is prohibited from issuing more senior debt unless net tangible assets exceed 200% of senior debt. Currently the company has outstanding $100 million of senior debt and has net tangible assets of $250 million. How much more senior debt can Al

> A puttable bond is a bond that may be repaid before maturity at the investor’s option. Sketch a diagram similar to Figure 24.3 showing the relationship between the value of a straight bond and that of a puttable bond.

> “A call option is always riskier than the stock it is written on.” True or false? How does the risk of an option change when the stock price changes?

> True or false? a. Convertible bonds are usually senior claims on the firm. b. The higher the conversion ratio, the more valuable the convertible. c. The higher the conversion price, the more valuable the convertible. d. Convertible bonds do not share ful

> Explain the three principal ways in which the terms of private placement bonds commonly differ from those of public issues.

> Look at Table 24.1:
a. Suppose the debenture was issued on September 1, 1992, at 99.489%. How much would you have to pay to buy one bond delivered on September 15? Don’t forget to include accrued interest. b. When is the first interest payment on the

> Use Table 24.1 (but not the text) to answer the following questions: a. Who are the principal underwriters for the J.C. Penney bond issue? b. Who is the trustee for the issue? c. How many dollars does the company receive for each debenture after deductio

> For each of the following sinking funds, state whether the fund increases or decreases the value of the bond at the time of issue (or whether it is impossible to say): a. An optional sinking fund operating by drawings at par. b. A mandatory sinking fund

> Select the most appropriate term from within the parentheses: a. (High-grade utility bonds/Low-grade industrial bonds) generally have only light sinking fund requirements. b. Collateral trust bonds are often issued by (utilities/industrial holding compan

> It was one of Morse’s most puzzling cases. That morning Rupert Thorndike, the autocratic CEO of Thorndike Oil, was found dead in a pool of blood on his bedroom floor. He had been shot through the head, but the door and windows were bol

> Look back at the first Backwoods Chemical example at the start of Section 23-1. Suppose that the firm’s book balance sheet is
The debt has a one-year maturity and a promised interest payment of 9%. Thus, the promised payment to Backwoods’s creditors is

> Digital Organics has 10 million outstanding shares trading at $25 per share. It also has a large amount of debt outstanding, all coming due in one year. The debt pays interest at 8%. It has a par (face) value of $350 million, but is trading at a market v

> How much would it cost you to insure the bonds of Backwoods Chemical against default? (See Section 23-1.) Section 23-1: (In 2009, Caesars Entertainment issued $3.7 billion of second lien notes maturing in 2018.1 By late 2014 these notes were trading at o

> Use the Black–Scholes formula to value the following options: a. A call option written on a stock selling for $60 per share with a $60 exercise price. The stock’s standard deviation is 6% per month. The option matures in three months. The risk free inte

> What problems are you likely to encounter when using a market-based approach for estimating the probability that a company will default?

> Discuss the problems with developing a numerical credit scoring system for evaluating personal loans. You can only test your system using data for applicants who have in the past been granted credit. Is this a potential problem?

> Company X has borrowed $150 maturing this year and $50 maturing in 10 years. Company Y has borrowed $200 maturing in five years. In both cases asset value is $140. Sketch a scenario in which X does not default but Y does.

> Company A has issued a single zero-coupon bond maturing in 10 years. Company B has issued a coupon bond maturing in 10 years. Explain why it is more complicated to value B’s debt than A’s.

> The following table shows some financial data for two companies:
Use the formula shown in Section 23-4 to calculate which has the higher probability of default.

> You own a 5% bond maturing in two years and priced at 87%. Suppose that there is a 10% chance that at maturity the bond will default and you will receive only 40% of the promised payment. What is the bond’s promised yield to maturity? What is its expecte

> Use the Black–Scholes model and redraw Figures 23.5 and 23.6 assuming that the standard deviation of the return on the firm’s assets is 40% a year. Do the calculations for 60% leverage only. (Hint: It is simplest to assume that the risk-free interest rat

> What variables are required to use a market-based approach to calculate the probability that a company will default on its debt?

> The difference between the value of a government bond and a simple corporate bond is equal to the value of an option. What is this option and what is its exercise price?

> Other things equal, would you expect the difference between the price of a Treasury bond and a corporate bond to increase or decrease with a. The company’s business risk? b. The degree of leverage?

> Over the coming year Ragwort’s stock price will halve to $50 from its current level of $100 or it will rise to $200. The one-year interest rate is 10%. a. What is the delta of a one-year call option on Ragwort stock with an exercise price of $100? b. U

> Why is it more difficult to estimate the value at risk for a portfolio of loans rather than for a single loan? Why did this pose a problem for rating agencies that needed to assess the risk of packages of mortgage loans before the financial crisis?

> You have an A-rated bond. Is a rise in rating more likely than a fall? Would your answer be the same if the bond were B-rated?

> Suppose you expect to need a new plant that will be ready to produce turbo-encabulators in 36 months. If design A is chosen, construction must begin immediately. Design B is more expensive, but you can wait 12 months before breaking ground. Figure 22.9 s

> In binomial trees, risk-neutral probabilities are set to generate an expected rate of return equal to the risk-free interest rate in each branch of the tree. What do you think of the following statement: “The value of an option to acquire an asset increa

> Respond to the following comments. a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash flows in the tree at the company cost of capital.” b. “These option pricing methods are just plain nutty. The